Large Inventory-Service Optimization in Configure-To-Order Systems

ABSTRACT

A manufacturing process is migrated from an existing operation to a configure-to-order (CTO) system. As the CTO operation will eliminate the “machine-type model” (MTM) inventory of the existing operation, the emphasis is shifted to the components, or “building blocks”, which will still follow the build-to-stock scheme, due to their long leadtimes, and hence still require inventory. The solution involves an inventory-service trade-off of the new CTO system, resulting in performance gains, in terms of reduced inventory cost and increased service level. Other benefits include better forecast accuracy through parts commonality and risk-pooling, and increased customer demand, as orders will no longer be confined within a restricted set of pre-configured MTMs.

BACKGROUND OF THE INVENTION

1. Field of the Invention

The present invention generally relates to computer assistedmanufacturing processes and, more particularly, to a model forre-engineering a build-to-stock operation to a configure-to-orderoperation centered around “building blocks”, thereby keeping inventoryonly at the component level.

2. Background Description

A configure-to-order (CTO) system is a hybrid of make-to-stock andmake-to-order operations: a set of components (subassemblies) are builtto stock whereas the end products are assembled to order. This hybridmodel is most suitable in an environment where the time it takes toassemble the end product is negligible, while theproduction/replenishment leadtime for each component is much moresubstantial. Personal Computer (PC) manufacturing is a good example ofsuch an environment. By keeping inventory at the component level,customer orders can be filled quickly. On the other hand, postponing thefinal assembly until order arrival provides a high level of flexibilityin terms of product variety, and also achieves resource pooling in termsof maximizing the usage of component inventory. Therefore, the CTOsystem appears to be an ideal business process model that provides bothmass customization and a quick response time to order fulfillment.

Such a hybrid model is often referred to as an assemble-to-order (ATO)system in the research literature. In an ATO system, usually there is apre-fixed set of end-product types from which customers must choose. Incontrast, a CTO system takes the ATO concept one step further, inallowing each customer to configure his/her own product in terms ofselecting a personalized set of components that go into the product.Aside from checking that the product so configured must “make sense”,there is no “menu” of product types that limits the customer's choice.

PC manufacturing traditionally has been a build-to-plan (orbuild-to-forecast) process, a process that is sometimes referred to asthe “machine-type model” (MTM) operation. There is a set of endproducts, or MTMs. Demand forecasts over a future planning horizon aregenerated for each MTM, and updated periodically for each planningcycle, typically, a weekly cycle. A “materials requirements planning”(MRP) type explosion technique is then used to determine therequirements for the components over the planning horizon, based on thebill-of-materials (BOM) structure of each end product. Because of therandom variation involved in demand forecasts, safety stock is usuallykept for each end product, as well as at each component level, in orderto meet a desirable customer service level. However, holding finishedgoods inventory for any length of time is very costly in the PCbusiness, where product life cycle is measured in months and pricereduction takes place almost every other week.

Y. Wang, “Service Levels in Production-Inventory Networks: Bottlenecks,Tradeoffs, and Optimization”, Ph.D. Dissertation, Columbia University,1988, applies an asymptotic result in an optimization problem tominimize average inventory holding cost with a constraint on the orderfill-rate. J. M. Swaminathan and S. R. Tayur, “Stochastic ProgrammingModels for Managing Product Variety”, in Quantitative Models for SupplyChain Management, S. Tayur, R. Ganeshan and M. Magazine (eds.), KluwerAcademic Publishers, Norwell, 1999, pp. 585-624, use stochasticprogramming models to study three different strategies at the assemblystage; utilizing component commonality, postponement (the “vanilla boxapproach”), and integrating assembly task design and operations. Otherrelated recent works, not necessarily in the CTO setting, include Y.Aviv and A. Federgruen, “The Benefits of Design for Postponement”, inQuantitative Models for Supply Chain Management, S. Tayur, R. Ganeshanand M. Magazine (eds.), Kluwer Academic Publishers, Norwell, 1999, pp.553-584, A. Garg and H. L. Lee, “Managing Product Variety: An OperationsPerspective”, in Quantitative Models for Supply Chain Management, S.Tayur, R. Ganeshan and M. Magazine (eds.), Kluwer Academic Publishers,Norwell, 1999, 467-490, L. Li, “The Role of Inventory in Delivery-TimeCompetition”, Management Science, 38 (1992), 182-197, and S. Mahajan andG. J. van Ryzin, “Retail Inventories and Consumer Choice”, inQuantitative Models for Supply Chain Management, S. Tayur, R. Ganeshanand M. Magazine (eds.), Kluwer Academic Publishers, Norwell, 1999,491-552.

SUMMARY OF THE INVENTION

The problem solved by the present invention is to migrate amanufacturing process from an existing operation to a Web-based CTOoperation where customer orders will be taken from the Internet. As theCTO operation will eliminate the MTM inventory, the emphasis will beshifted to the components, or “building blocks”, which will still followthe build-to-plan scheme, due to their long leadtimes, and hence stillrequire inventory. The solution involves an inventory-service trade-offof the new CTO system, with resulting the performance gains, in terms ofreduced inventory cost and increased service level. There are otherbenefits: There will be better forecast accuracy through partscommonality and risk-pooling. Customer demand is expected to increase,as orders will no longer be confined within a restricted set ofpre-configured MTMs.

Whereas most studies in the literature focus on certain segments of thesupply chain, modeled as simple stand-alone queues, the presentinvention aims at modeling large-scale, end-to-end enterprise supplychains, such as those in the PC industry. The centerpiece of theinvention is a network of inventory queues, which integrates inventorycontrol with the delay-capacity features of queues. The networkconfiguration is determined by the bill of materials (BOM) structure ofthe end products. The solution approach is a decomposition-basedapproximation, coupled with nonlinear optimization using conjugategradient search. The model can be used not only to study theinventory-service tradeoff, but also to compare the effects on inventoryand service performances through changing the network configuration;i.e., the supply chain structure, and to identify the bestconfiguration.

BRIEF DESCRIPTION OF THE DRAWINGS

The foregoing and other objects, aspects and advantages will be betterunderstood from the following detailed description of a preferredembodiment of the invention with reference to the drawings, in which:

FIG. 1 is a diagram illustrating an example of a bill-of-materialstructure of seven components used to produce three end products in anconfigure-to-order system;

FIGS. 2A and 2B, taken together, are a flow diagram of an implementationof the inventory optimization algorithm according to the invention;

FIGS. 3A and 3B, taken together, are a block diagram showing a hardwareplatform on which the invention may be implemented;

FIG. 4 is a graph of optimal days-of-supply for selected components innon-stationary demand environment for a target service level of 95%;

FIG. 5 is a graph showing a comparison between a build-to-stock(“as-is”) and an configure-to-order (“to-be”) system;

FIG. 6 is a graph showing the effect of improving forecast accuracy; and

FIG. 7 is a graph showing the effect of product variety on inventory.

DETAILED DESCRIPTION OF A PREFERRED EMBODIMENT OF THE INVENTION

We consider a hybrid model, by which each end product is configured toorder from a set of components, which, in turn, are built to stock. Inother words, no finished goods inventory is kept for any end product,whereas each component (“building block”) has its own inventory,replenished from a supplier following a base-stock policy.

Referring now to the drawings, and more particularly to FIG. 1, there isshown a diagram illustrating an example of this hybrid model.Abstractly, there are seven components comprising the set S={1, 2, . . ., 7} which are used in various combinations to produce three endproducts comprising the set M={1, 2, 3}. The components are maintainedin inventory, but no inventory is maintained of end products. Eachcomponent inventory is indexed by i, iεS, where S denotes the set of allcomponents. Associated with each component is a “store”, where theinventory is kept.

ATO Environment

First, consider the traditional ATO environment. That is, there is apre-specified set of end products (i.e., machine type models), with eachtype indexed by in mεM where M denotes the set of all product types. Foreach product type, there is a corresponding demand stream.

Time is discrete, indexed by t, with each time unit called a period. LetD_(m)(t) denote the demand of type m in period t. Each unit of type indemand requires a subset of components, denoted S_(m) ⊂S, possibly withmultiple units of each component. From the BOM structure of the endproduct, we can identify M_(i) as the subset of end products that allrequire component T as part of the assembly. That is, M_(i)={m:iεS_(m)}.

There are two kinds of leadtimes; those associated with the components,and those associated with the end-products:

-   -   L_(i) ^(in), iεS: the in-bound leadtime—the time for the        supplier of component i to replenish to store i once an order is        placed. Assume this leadtime is known through a given        distribution. For instance, a normal distribution with mean and        variance given.    -   L_(i) ^(out), mεM: the out-bound leadtime—the time to supply a        customer demand of type in, provided there is no stockout of any        component iεS_(m). This time includes the order processing time,        the assembly/reconfiguration time, and the transportation time        to deliver the order. The distribution of this leadtime is also        assumed known.

We can now express the demand at store i in period t, for any iεS andany t=1, 2, . . . , as follows:

${D_{i}(t)} = {\sum\limits_{m \in M_{i}}{{D_{m}\left( {t + L_{m}^{out}} \right)}.}}$

Note this is the standard MRP type of demand-leadtime offset. We derivethe mean and variance for D_(i)(t) as follows:

$\begin{matrix}{\mspace{20mu} {{{E\left\lbrack {D_{i}(t)} \right\rbrack} = {\sum\limits_{m \in M_{i}}{\sum\limits_{}{{E\left\lbrack {D_{m}\left( {t + } \right)} \right\rbrack}{P\left\lbrack {L_{m}^{out} = } \right\rbrack}}}}},}} & (1) \\{{{Var}\left\lbrack {D_{i}(t)} \right\rbrack} = {{\sum\limits_{m \in M_{i}}{\sum\limits_{}{{E\left\lbrack {D_{m}^{2}\left( {t + } \right)} \right\rbrack}{P\left\lbrack {L_{m}^{out} = } \right\rbrack}}}} - {\sum\limits_{m \in M_{i}}\left( {\sum\limits_{}{{E\left\lbrack {D_{m}\left( {t + } \right)} \right\rbrack}{P\left\lbrack {L_{m}^{out} = } \right\rbrack}}} \right)^{2}}}} & (2)\end{matrix}$

The variance calculation above assumes independence among demandclasses; for correlated demands, simply add to the above the covarianceterms.

CTO Environment

The above analysis is now adapted to the CTO environment. In thisenvironment, there is no pre-specified product menu; in principle, everyorder can require a distinct set of components. Hence, we use M todenote the set of product/demand families that use the same set ofcomponents S. For instance, M={low-end machines, high-end machines,servers}; or M={individuals, small business, corporations}.

Suppose D_(m) is the demand associated with product family m in acertain period (for simplicity, the time argument t is omitted). Supposeeach unit (order) in D_(m) requires a random number of units fromcomponent i, denoted as X_(mi), which takes on non-negative integervalues. The sets M and M_(i) are still defined as before, but they nowtake on the following form:

S _(m) =S−{i:X _(mi)=0}, and M _(i) =M−{m:X _(mi)=0}

We can then translate the end-product demand into demand for eachcomponent i (per period).

$D_{i} = {\sum\limits_{m \in M_{i}}{\sum\limits_{k = 1}^{D_{m}}{{X_{m\; i}(k)}.}}}$

where X_(mi)(k), for k=1, 2, . . . , are independent, identicallydistributed (i.i.d.) copies of X_(mi). Assume the mean and the varianceof X_(mi) are known. For instance, starting from the joint distributionof (X_(mi))_(iεS) _(m) , derived from empirical demand data, we canderive the marginal distributions, and then the mean and the variance ofX_(mi). Applying Wald's identity (S. M. Ross, Stochastic Processes, JohnWiley & Sons, New York, 1996), we can derive:

$\begin{matrix}{{{E\left\lbrack D_{i} \right\rbrack} = {\sum\limits_{m \in M_{i}}{{E\left\lbrack X_{m\; i} \right\rbrack}{E\left\lbrack D_{m} \right\rbrack}}}},} & (3) \\\begin{matrix}{{{Var}\left\lbrack D_{i} \right\rbrack} = {\sum\limits_{m \in M_{i}}\left( {{{E\left\lbrack D_{m} \right\rbrack}{{Var}\left\lbrack X_{m\; i} \right\rbrack}} + {{{Var}\left\lbrack D_{m} \right\rbrack}{E^{2}\left\lbrack X_{m\; i} \right\rbrack}}} \right)}} \\{= {\sum\limits_{m \in M_{i}}\begin{pmatrix}{{{E^{2}\left\lbrack X_{m\; i} \right\rbrack}{E\left\lbrack D_{m}^{2} \right\rbrack}} +} \\{{{{Var}\left\lbrack X_{m\; i} \right\rbrack}{E\left\lbrack D_{m} \right\rbrack}} - {{E^{2}\left\lbrack X_{m\; i} \right\rbrack}{E^{2}\left\lbrack D_{m} \right\rbrack}}}\end{pmatrix}}}\end{matrix} & (4)\end{matrix}$

Therefore, equations (1) and (2) can be generalized as follows:

$\begin{matrix}{\mspace{20mu} {{{E\left\lbrack {D_{i}(t)} \right\rbrack} = {\sum\limits_{m \in M_{i}}{{E\left\lbrack X_{m\; i} \right\rbrack}{\sum\limits_{}{{E\left\lbrack {D_{m}\left( {t + } \right)} \right\rbrack}{P\left\lbrack {L_{m}^{out} = } \right\rbrack}}}}}},}} & (5) \\{{{Var}\left\lbrack {D_{i}(t)} \right\rbrack} = {{\sum\limits_{m \in M_{i}}{{E^{2}\left( X_{m\; i} \right)}{\sum\limits_{}{{E\left\lbrack {D_{m}^{2}\left( {t + } \right)} \right\rbrack}{P\left\lbrack {L_{m}^{out} = } \right\rbrack}}}}} + {\sum\limits_{m \in M_{i}}{{{Var}\left( X_{m\; i} \right)}{\sum\limits_{}{{E\left\lbrack {D_{m}\left( {t + } \right)} \right\rbrack}{P\left\lbrack {L_{m}^{out} = } \right\rbrack}}}}} - {\sum\limits_{m \in M_{i}}{{E^{2}\left( X_{m\; i} \right)}{\left( {\sum\limits_{}{{E\left\lbrack {D_{m}\left( {t + } \right)} \right\rbrack}{P\left\lbrack {L_{m}^{out} = } \right\rbrack}}} \right)^{2}.}}}}} & (6)\end{matrix}$

Base-Stock Control

As mentioned above, suppose each store i follows a base-stock policy.Let R_(i)(t) denote the reorder point (or, base-stock level) in periodt. Express the reorder point as follows:

R _(i)(t):=μ_(i)(t)+k _(i)(t)σ_(i)(t),  (7)

where k_(i)(t) is the desired safety factor, while μ_(i)(t) and σ_(i)(t)can be derived (via queuing analysis as follows:

$\begin{matrix}{{{\mu_{i}(t)} = {\sum\limits_{s = t}^{t + _{i}^{i\; n} - 1}{E\left\lbrack {D_{i}(s)} \right\rbrack}}},} & (8) \\{{{\sigma_{i}^{2}(t)} = {\sum\limits_{s = t}^{t + _{i}^{i\; n} - 1}{{Var}\left\lbrack {D_{i}(s)} \right\rbrack}}},} & (9)\end{matrix}$

where l_(i) ^(in):=E[L_(i) ^(in)] is the expected in-bound leadtime, andE[D_(i)(s)] and Var[D_(i)(s)] follow equations (1) and (2),respectively. Note that since time is discrete, we shall round up anyreal-valued l_(i) ^(in) to the next integer to be used in equations (8)and (9). Also note that the reason we choose to write R_(i)(t) as inequation (7) is because we model the demand as follows:

D _(i)(t)=μ_(i)(t)+σ_(i)(t)·Z,  (10)

where Z denotes the standard normal variate.

To facilitate implementation, it is often desirable to translateR_(i)(t) into “days of supply” (DOS), or more precisely, periods ofsupply. To do so, note that the μ_(i)(t) part of R_(i)(t) simplytranslates into periods of demand. In addition, we can turn thek_(i)(t)σ_(i)(t) part of R_(i)(t) into

$\frac{{k_{i}(t)}{\sigma_{i}(t)}}{\frac{\mu_{i}(t)}{_{i}^{i\; n}}}$

periods of demand. Hence, we can express R_(i)(t) in terms of periods ofdemand, or DOS, as follows:

$\begin{matrix}{{{DOS}_{i}(t)} = {_{i}^{i\; n}\left\lbrack {1 + {{k_{i}(t)}\frac{\sigma_{i}(t)}{\mu_{i}(t)}}} \right\rbrack}} & (11)\end{matrix}$

Note the intuitively appealing form of equation (11), in particular thesafety-stock (or rather, safety time) part, which is equal to theproduct of the safety factor and the coefficient of variation (i.e., theratio of standard deviation to mean) of the component demand over the(in-bound) leadtime.

For the inventory performance measures, the expected on-hand inventoryand back-order level are as follows:

E[I _(i)(t)]=σ_(i)(t)H(k _(i)(t)), E[B _(i)(t)]=σ_(i)(t)G(k_(i)(t)).  (12)

Here the function G(•) is defined as:

G(x):=E[Z−x] ⁺=∫_(x) ^(∞)(z−x)φ(z)dz=φ(x)−x Φ( x),  (13)

with Z denoting the standard normal variate, φ and Φ denoting,respectively, the density function and the distribution function of Z,and Φ:=1−Φ(x). The function H(•) is defined as:

H(x):=E[x−Z] ⁺ =x+G(x)=φ(x)+xΦ(x).  (14)

Note that the expressions in (12) are based on the following identities:

I _(i)(t)=[R _(i)(t)−D _(i)(t)]⁺ and B _(i)(t)=[D _(i)(t)−R _(i)(t)]⁺;

along with equations (7) and (10). Furthermore, we have

P[D _(i)(t)≧R _(i)(t)]=P[Z≧k _(i)(t)]= Φ(k _(i)(t)),  (15)

which relates to the service requirement to be elaborated in the nextsection.

Next, suppose demand is stationary, i.e., for each demand class m,D_(m)(t) is invariant in distribution over time. Then, the mean and thevariance of demand per period for each component i follow theexpressions in (3) and (4). Consequently, (8) and (9) reduce to thefollowing

μ_(i) =l _(i) ^(in) E[D _(i)], and σ_(i) ² =l _(i) ^(in) Var[D_(i)].  (16)

We can then write

R _(i) =l _(i) ^(in) E[D _(i) ]+k _(i) √{square root over (l _(i)^(in))}sd[D_(i)];  (17)

and hence,

$\begin{matrix}{{{DOS}_{i} = {\frac{R_{i}}{E\left\lbrack D_{i} \right\rbrack} = {{_{i}^{i\; n} + {k_{i}\theta_{i}\sqrt{_{i}^{i\; n}}}} = {_{i}^{i\; n}\left\lbrack {1 + {k_{i}\frac{\theta_{i}}{\sqrt{_{i}^{i\; n}}}}} \right\rbrack}}}},} & (18)\end{matrix}$

where θ_(i):=sd[D_(i)]/E[D_(i)] is the coefficient of variation of thedemand per period for component i. (Hence, θ_(i)/√{square root over(l_(i) ^(in))} is the coefficient of variation of the demand over theleadtime l_(i) ^(in), which is consistent with the general formula inequation (11).)

Sometimes it is more appropriate to adjust the demand distribution toaccount for non-negativity. Specifically, instead of D=μ+σZ, where Z isthe standard normal variate, we should have {tilde over (D)}=[μ+σZ]⁺.The adjusted mean follows from equation (13) as follows:

$\begin{matrix}{{E\left\lbrack \overset{\sim}{D} \right\rbrack} = {{\sigma \; {E\left\lbrack {Z - \left( {- \frac{\mu}{\sigma}} \right)} \right\rbrack}^{+}} = {\sigma \; {{G\left( {- \frac{\mu}{\sigma}} \right)}.}}}} & (19)\end{matrix}$

To derive the adjusted variance, note the following:

$\begin{matrix}{{E\left\{ \left\lbrack \left( {Z - x} \right)^{+} \right\rbrack^{2} \right\}} = {\int_{x}^{\infty}{\left( {z - x} \right)^{2}{\varphi (z)}{z}}}} \\{= {{x\; {\varphi (x)}} + {\overset{\_}{\Phi}(x)} - {2x\; {\varphi (x)}} + {x^{2}{\overset{\_}{\Phi}(x)}}}} \\{{= {{\overset{\_}{\Phi}(x)} - {x\; {G(x)}}}},}\end{matrix}$

where the last equation makes use of equation (13). Hence,

$\begin{matrix}\begin{matrix}{{{Var}\left\lbrack \overset{\sim}{D} \right\rbrack} = {\sigma^{2}{Var}\left\{ \left\lbrack {Z - \left( {- \; \frac{\mu}{\sigma}} \right)} \right\rbrack^{+} \right\}}} \\{= {{\sigma^{2}E\left\{ \left\lbrack \left( {Z - \left( {- \frac{\mu}{\sigma}} \right)} \right)^{+} \right\rbrack^{2} \right\}} - \left\lbrack {E\left( \overset{\sim}{D} \right)} \right\rbrack^{2}}} \\{= {{\sigma^{2}\left\lbrack {{\overset{\_}{\Phi}\left( {- \frac{\mu}{\sigma}} \right)} + {\frac{\mu}{\sigma}{G\left( {- \frac{\mu}{\sigma}} \right)}} - {G^{2}\left( {- \frac{\mu}{\sigma}} \right)}} \right\rbrack}.}}\end{matrix} & (20)\end{matrix}$

For moderately large x (say, x≧2), from equation (13), we have G(−x)≅x,and hence

E[{tilde over (D)}]≅E[D], Var[{tilde over (D)}]≅Var[D],

from equations (19) and (20). Therefore, the above adjustment is onlyneeded when the coefficient of variation of the demand, σ/μ, isrelatively large, say, 0.5 or above.

From equations (7), (17) and (18), it is clear that to identify thebase-stock policy is tantamount to specifying the safety factor k_(i)for each component inventory. In the following sections, we discuss howto set the safety factor values so as to achieve the bestinventory-service performance as specified in the optimization problemsbelow.

For ease of exposition, we shall focus on stationary demand. Fornon-stationary demand, we can simply solve the optimization problemsbelow period by period.

Service Requirement

To start with, consider the special case of each order of type mrequires exactly one unit of component iεS_(m). Let α be the requiredservice level, defined here as the off-shelf availability of all thecomponents required to configure a unit of type m product, for any m.Let E_(i) denote the event that component i is out of stock. Then, werequire, for each end product mεM,

P[∪ _(iεS) _(m) E _(i)]≦1−α.

From the well-known inclusion-exclusion formula:

${{P\left\lbrack {\bigcup_{i \in S_{m}}E_{i}} \right\rbrack} = {{\sum\limits_{i}{P\left( E_{i} \right)}} - {\sum\limits_{i < j}{P\left( {E_{i}\bigcup E_{j}} \right)}} + {\sum\limits_{i < j < k}{P\left( {E_{i}\bigcup E_{j}\bigcup E_{k}} \right)}} - \ldots}}\mspace{14mu},$

we have, as an approximation,

$\begin{matrix}{{{P\left\lbrack \bigcup_{i \in S_{m}} \right\rbrack} \cong {\sum\limits_{i \in S_{m}}{P\left( E_{i} \right)}}} = {{\sum\limits_{i \in S_{m}}{\overset{\_}{\Phi}\left( k_{i} \right)}} \leq {1 - {\alpha.}}}} & (21)\end{matrix}$

There is another way to arrive at the above inequality. Suppose weexpress the service requirement as follows:

$\begin{matrix}{{{\prod\limits_{i \in S_{m}}{\Phi \left( k_{i} \right)}} \geq \alpha},{m \in {M.}}} & (22)\end{matrix}$

Note that the left hand side in inequality (22) is, in fact, a lowerbound of the no-stockout probability of the set of components in S_(m)that is required to configure the end-product m; i.e., it is a lowerbound of the desired off-shelf availability. This claim (of a lowerbound) can be argued by using stochastic comparison techniques involvingthe notion of association. (Refer to, e.g., S. M. Ross, StochasticProcesses, 2^(nd) ed., Wiley, New York (1998), for backgroundmaterials.) Intuitively, since the component inventories are driven by acommon demand stream {D_(m)(t)}, and hence positively correlated, thechance of missing one or several components must be less than when thecomponent inventories are independent, which is what is assumed by theproduct on the left hand side of inequality (22).

Since

${{\prod\limits_{i \in S_{m}}{\Phi \left( k_{i} \right)}} = {{\prod\limits_{i \in S_{m}}\left\lbrack {1 - {\overset{\_}{\Phi}\left( k_{i} \right)}} \right\rbrack} \cong {1 - {\sum\limits_{i \in S_{m}}{\overset{\_}{\Phi}\left( k_{i} \right)}}}}},$

combining the above and inequality (22), we arrive at the sameinequality in (21).

In the general setting of CTO, consider demand of product family m. LetA⊂S_(m) denote a certain configuration, which occurs in this demandstream with probability P(A). Then the no-stockout probability,Π_(iεA)Φ(k_(i)), should be weighted by P(A). Hence, the servicerequirement in (22) should be changed to

$\begin{matrix}\begin{matrix}{\alpha \leq {\sum\limits_{A \Subset S_{m}}{{P(A)}{\prod\limits_{i \in A}{\Phi \left( k_{i} \right)}}}}} \\{\approx {\sum\limits_{A \Subset S_{m}}{{P(A)}\left\lbrack {1 - {\sum\limits_{i \in A}{\overset{\_}{\Phi}\left( k_{i} \right)}}} \right\rbrack}}} \\{= {1 - {\sum\limits_{i \Subset S_{m}}{{P(A)}{\sum\limits_{i \in A}{\overset{\_}{\Phi}\left( k_{i} \right)}}}}}} \\{= {1 - {\sum\limits_{i \in S_{m}}{\left( {\sum\limits_{i \in A}{P(A)}} \right){{\overset{\_}{\Phi}\left( k_{i} \right)}.}}}}}\end{matrix} & (23) \\{{Since}{{{\sum\limits_{i \in A}{P(A)}} = {{P\left( {X_{m\; i} > 0} \right)}:=r_{m\; i}}},}} & \;\end{matrix}$

in the CTO environment the service requirement in (21) can be extendedto the following:

$\begin{matrix}{{{\sum\limits_{i \in S_{m}}{r_{{m\; i}\;}{\overset{\_}{\Phi}\left( k_{i} \right)}}} \leq {1 - \alpha}},} & (24)\end{matrix}$

where r_(mi) follows (23).

Note that in the CTO environment, in particular when X_(mi)≧1, thestockout at component i should occur more often than Φ(k_(i)) due to thebatch size associated with each order. In particular, (15) should bemodified as follows (omitting the time argument t):

${{P\left\lbrack {{D_{i} + X_{{m\; i}\;}} \geq R_{i}} \right\rbrack} = {{P\left\lbrack {Z \geq {k_{i} - \frac{X_{{m\; i}\;}}{\sigma_{i}}}} \right\rbrack} = {\overset{\_}{\Phi}\left( {k_{i} - \frac{X_{{m\; i}\;}}{\sigma_{i}}} \right)}}},$

which is larger than Φ(k_(i)). But this gap should be insignificant,since

${\frac{X_{m\; i}}{\sigma_{i}} = \frac{X_{m\; i}}{\theta_{i}\mu_{i}}},$

where θ_(i):=σ/μ_(i) is the coefficient of variation (or, forecasterror); and the batch size of incoming orders is usually orders ofmagnitude smaller when compared against μ_(i), which is the mean ofdemand summed over all product types mεM_(i) and over the leadtime. Alsonote that this underestimation of the stockout probability iscompensated by the overestimation involved in (22), since the latter isa lower bound of the no-stockout probability.

We can now relate the above off-shelf availability requirement to thestandard customer service requirements expressed in terms of leadtimes,W_(m). Suppose the required service level of type m demand is:

P[W _(m) ≦w _(m) ]≧α, mεM,  (25)

where w_(m)'s are given data.

Consider type m demand. We have the following two cases:

-   -   (i) When there is no stockout at any store iεS_(m)—denoting the        associated probability as π_(0m)(t), the delay is simply L_(i)        ^(out), the out-bound leadtime.    -   (ii) Suppose there is a stockout at one or several stores in the        subset s⊂S_(m). Denote the associated probability as πs_(m)(t).        Then, the delay becomes L_(i) ^(out)+τ_(s), where τ_(s) is the        additional delay before the missing components in s become        available.        Hence, we can write

$\begin{matrix}{{P\left\lbrack {W_{m} \leq w_{m}} \right\rbrack} = {{{\pi_{0m}(t)}{P\left\lbrack {L_{m}^{out} \leq w_{m}} \right\rbrack}} + {\sum\limits_{s \in S_{m}}{{\pi_{sm}(t)}{{P\left\lbrack {{L_{m}^{out} + \tau_{s}} \leq w_{m}} \right\rbrack}.}}}}} & (26)\end{matrix}$

In most applications, it is reasonable to assume that

L _(m) ^(out) ≦w _(m) and L _(m) ^(out)+τ_(s) >w _(m)  (27)

both hold almost surely. For instance, this is the case when the(nominal) outbound leadtime is nearly deterministic and shorter thanwhat the customers require (this is, after all, a preconditionfor-running an configure-to-order operation); whereas the replenishleadtime for any component is substantially longer, hence it isvirtually impossible to meet the customer service requirement in thecase of any component stockout.

Clearly, with the assumed inequalities in (27), the first probability onthe right hand side of (26) becomes one, and the probabilities under thesummation all become zero. Consequently, the leadtime servicerequirement in (25) reduces to the off-shelf availability π_(0m), and alower bound of the latter is the left hand side of (22), as we explainedearlier.

Inventory-Service Optimization

Our objective is to minimize the maximum stockout probability among allend-products subject to a given inventory budget. In view of equation(21) and the more general service contraint in (24), the problem can bepresented as follows:

$\min \; {\max\limits_{m \in M}\left\{ {\sum\limits_{i \in S_{m}}{r_{{m\; i}\;}{\Phi \left( k_{i} \right)}}} \right\}}$${{s.t.\mspace{14mu} {\sum\limits_{i \in S}{c_{i}\sigma_{i}{H\left( k_{i} \right)}}}} \leq B},$

where c_(i) is the unit cost of the on-hand inventory of component, i,and B>0 is a given parameter, the budget limit on the expected overallinventory cost. Recall that σ_(i)H(k_(i)) is the expected on-handinventory of component i (refer to equation (12)) and σ_(i) follows thespecification in equation (16).

To solve the above optimization problem, we first apply a transformationof variables. Let

x _(i):= Φ(k _(i)), or k _(i)= Φ ⁻¹(x _(i)).  (28)

Next, denote

g(x):=H( Φ ⁻¹(x)).

We can then reformulate the problem as follows:

$\begin{matrix}{\min \; \beta} & (29) \\{{{s.t.\mspace{14mu} {\sum\limits_{i \in S_{m}}{r_{m\; i}x_{i}}}} \leq \beta},{m \in M}} & (30) \\{{\sum\limits_{i \in S}{c_{i}\sigma_{i}{g\left( x_{i} \right)}}} \leq \beta} & (31)\end{matrix}$

Here, the objective value β represents the upper limit on the stockoutprobability (or, “no-fill rate”) over any product types.

Several remarks are in order:

-   -   (i) Note that H(•) is an increasing and convex function, as        evident from the first equality in equation (14), while is        decreasing and convex (convex when the variable takes values on        the non-negative half-line). Hence, g(•) is a decreasing and        convex function.    -   (ii) For two-end-products, m and m′, if S_(m′)⊂S_(m) and        r_(m′i)≦r_(mi) for iεS_(m′), then the constraint corresponding        to m′ becomes superfluous. We assume in the above formulation,        all such superfluous constraints have already been removed        through preprocessing: (Note, however, the demand for such        end-products (as type m′) will still contribute to the        calculation of σ_(i) in inequality (31), if m′εM_(i).)    -   (iii) The constraint in inequality (31) is always binding, since        g(•) is decreasing as explained in (i).

The Lagrangian corresponding to the above optimization problem is:

${L = {B + {\sum\limits_{m \in M}{\lambda_{m}\left( {{\sum\limits_{i \in S_{m}}{r_{{m\; i}\;}x_{i}}} - \beta} \right)}} + {\eta\left\lbrack {{\sum\limits_{i \in S}{c_{i}\sigma_{i}{g\left( x_{i} \right)}}} - B} \right\rbrack}}},$

where λ_(m)>0 (mεM) and η≧0 are the Lagrangian multipliers. Hence, theoptimal solution can be obtained from solving the following system ofnon-linear equations:

$\begin{matrix}{{{\sum\limits_{m \in M}{r_{{m\; i}\;}\lambda_{m}}} = {{- \eta}\; c_{i}\sigma_{i}{g^{\prime}\left( x_{i} \right)}}},{i \in S}} & (32) \\{{\sum\limits_{m \in M}\lambda_{m}} = 1} & (33) \\{{\sum\limits_{i \in S}{c_{i}\sigma_{i}{g\left( x_{i} \right)}}} = B} & (34) \\{{{\sum\limits_{i \in S_{m}}{r_{{m\; i}\;}x_{i}}} = \beta},{m \in {{M\mspace{14mu} {and}\mspace{14mu} \lambda_{m}} > 0}}} & (35)\end{matrix}$

As there is no easy way to solve the above system of non-linearequations, we propose a greedy algorithm, which works as follows: Wefirst discretize the problem—let Δ be the step size. For instance, setΔ=0.01% (one basis points), and start with x_(i)=0 for all i. At eachstep, we identify the variable x_(i*), such that increasing x_(i*) tox_(i*)+Δ will yield the smallest increase in the objective value. Thiscorresponds to identifying whether the maximum, over all mεM, of theleft hand side of inequality (30) will either (i) remain the same or(ii) increase by a positive amount.

Consider case (i) first, i.e., there is a subset, denoted A⊂S, such thatfor any iεA, we can increase x_(i) to x_(i)+Δ, without affecting thecurrent β value in the algorithm. In this case, we pick the index i*εAas follows:

$\begin{matrix}{i^{*} = {\arg \; {\max\limits_{i \in A}{\left\{ {c_{i}{{\sigma_{i}\left\lbrack {{g\left( x_{i} \right)} - {g\left( {x_{i} + \Delta} \right)}} \right\rbrack}/r_{{m\; i}\;}}} \right\}.}}}} & (36)\end{matrix}$

In the complement case (ii), increasing x_(i) (by Δ) for any iεS willresult in a positive increase in the β value. In this case, we stillfollow (36) to pick the index i*, replacing A by S. That is, we choosei* such that it will result in the smallest increase in β but in thelargest reduction in inventory budget.

The above procedure is continued until the inventory budget constraintis satisfied; i.e., until the left hand side of inequality (31) isbrought down to B or less.

The main computation involved in each step of the above algorithm is toevaluate the increment

c _(i)σ_(i) [g(x _(i))−g(x _(i)+Δ)].

Since Δ is a small increment, we can approximate the above difference bythe derivative,

c _(i)σ_(i) [−g′(x _(i)+Δ/2)]·Δ.

Note that from equation (10), we have

$\begin{matrix}{{{H^{\prime}(x)} = {{{{- x}\; {\varphi (x)}} + {\Phi (x)} + {x\; {\varphi (x)}}} = {{\Phi (x)}.{And}}}},{\left\lbrack {{\overset{\_}{\Phi}}^{- 1}(x)} \right\rbrack^{\prime} = {\frac{- 1}{\varphi \left( {{\overset{\_}{\Phi}}^{- 1}(x)} \right)}.{Hence}}},{{- {g^{\prime}(x)}} = {{{- {\Phi \left( {{\overset{\_}{\Phi}}^{- 1}(x)} \right)}} \cdot \frac{- 1}{\varphi \left( {{\overset{\_}{\Phi}}^{- 1}(x)} \right)}} = {\frac{1 - x}{\varphi \left( {{\overset{\_}{\Phi}}^{- 1}(x)} \right)}.}}}} & (37)\end{matrix}$

To summarize, the algorithm is implemented as illustrated in the flowdiagram of FIG. 2. The process begins with an initialization phase infunction block 201 in which:

For each iεS, set x_(i):=0.

For each iεS, set r_(mi):=P(X_(mi)>0)

For each mεM, set β_(m):=0.

Set β:=0.

At this point, the process enters the outer one of three nestedprocessing loops. The first step is to initialize the set of activebuilding blocks, A, to A={ } in function block 202. Then the secondprocessing loop is entered in function block 203 which considers eachiεS, followed by entering the third processing loop in function block204 which considers each end product m that uses component i in itsbill-of-material. In function block 205, set β_(m):=β_(m)+r_(mi)Δ, forall m such that iεS_(m) to perform the processing in the third nestedprocessing loop. Then, in function block 206, computeδ_(i):=max_(m){β_(m)}−β. A determination is made in decision block 207to determine if δ_(i)≦0. If so, then add i to the set of active buildingblocks, A:=A+{i}, to complete the processing in the second nestedprocessing loop. In function block 208, determine if the set of activecomponents A is non-empty; if so, set B:=A. otherwise set B:=S where Bis a set of component indexes. In function block 209, find i*:=argmax_(iεB){−c_(i)σ_(i)/r_(mi)g′(x_(i)+Δ/2)}, where −g′(•) followsequation (37). In function block 210, set x_(i)*:=x_(i)*+Δ to update theno-stockout probability of component i*. In function block 211, computeβ=max_(mεM)β_(m), and in function block 212, check whether inequality(31) is satisfied. If yes, stop; otherwise, in function block 213 updateβ_(m) for each mεM_(i*), set β_(m):=β_(m)+r_(mi)Δ, and go to functionblock 202 to complete the first processing loop.

When there is only a single product type, the above algorithm isguaranteed to yield the optimal solution (modulo the discretization).For multiple product types, to solve the problem to optimality wouldrequire, at each step, the examination of all subsets of S, instead ofjust the individual components iεS. For instance, if components i and jare involved in two different product types, then it is possible, atsome step, to increase both x_(i) and x_(j) to x_(i)+Δ and x_(j)+Δwithout increasing the objective value.

Another case of interest is when each end product has (at least) oneunique component, which we denote as im for product m. That is, M_(i)_(m) ={i_(m)} is a singleton set. In this case, it is quite easy tocheck the solution returned by the greedy algorithm to determine whetherthe solution satisfies the optimality conditions in equations (32) to(35). To do so, first note that equation (34) is always satisfied.Furthermore, equation (35) is also automatically satisfied in this case.For if Σ_(iεS) _(l) _(r) _(mi) _(x) _(i)<β for some end product lεM,then we can always increase the value of x_(i), that corresponds to theunique component i_(l); and this will only decrease the overallinventory budget, since g(x_(i) _(l) ) is decreasing in x_(i) _(l) .Hence, we only need to check equations (32) and (33). From equation(32), taking into account M_(i) _(l) ={i_(m)}, we obtain

${\lambda_{m} = {\eta \; \frac{c_{i_{m}}\sigma_{i_{m}}{g^{\prime}\left( x_{i_{m}} \right)}}{r_{m\; i_{m}}}}},{m \in M},$

which, along with equation (33), yields

$\eta = {\left\lbrack {\sum\limits_{m \in M}\frac{c_{i_{m}}\sigma_{i_{m}}{g^{\prime}\left( x_{i_{m}} \right)}}{r_{m\; i_{m}}}} \right\rbrack^{- 1}.}$

What then remains is to check whether or not the λ_(m)'s and η derivedfrom the above, along with the x_(i)'s returned from the algorithm,satisfy equation (32), for iεS\{i_(m), mεM}, the non-unique components.

The “dual” to the above optimization problem is to minimize the expectedtotal inventory cost, subject to the stockout probability of eachproduct no greater than β, a given parameter. That is,

$\begin{matrix}{\min {\sum\limits_{i \in S}{c_{i}\sigma_{i}{H\left( {{\overset{\_}{\Phi}}^{- 1}\left( x_{i} \right)} \right)}}}} & (38) \\{{{s.t.\mspace{14mu} {\sum\limits_{i \in S_{m}}{r_{m\; i}x_{i}}}} \leq \beta},{m \in M}} & (39)\end{matrix}$

The greedy heuristic described earlier still applies. The onlydifference is the stopping criterion. Here, we stop when some (if notall) of the constraints in (39) become binding such that no x_(i) valuescan be further increased. (That is, the set of end products correspondsto these binding constraints spans over the entire set of components S.)

FIG. 3 illustrates in block diagram form a hardware platform on whichthe algorithm illustrated in the flow diagram of FIG. 2 may beimplemented. There are illustrated two databases 301 and 302 whichprovide inputs to processor 303. Database 301 contains optimizationcontrol parameters; specifically, budget limit on expected overallinventory cost and step size for the greedy algorithm. Database 302contains manufacturing system parameters. These are (i) demand for endproduct mεM in period t=1, 2, . . . , T, (ii) inbound leadtimedistribution for component iεS, (iii) outbound leadtime distribution forend product mεM, (iv) the distribution of the number of units ofcomponent i used in the assembly of end product mεM, (v) unit cost ofcomponent iεS, and (5) bill-of-materials for end product mεM. Theprocessor 303 accesses these databases and first performs preprocessingsteps of propagating demand using equations (5) and (6) and computingthe mean and variance of the demand over the leadtime using equation(16). After the preprocessing, the processor performs optimizationprocessing. This includes applying variable transformation usingequation (28), reformulating the optimization problem using equations(29) to (31), and solving the optimization problem through the greedyalgorithm as illustrated in the flow diagram of FIG. 2. Finally, theprocessor enters the postprocessing phase where the reorder points arecomputed using equations (5), (6), (17), and (28) and the reorder pointsare translated into days-of-supply using equation (18). The processor303 outputs the computed information to an output device or database304, this information including output days-of-supply for each componentiFS and output achieved service level for each end product meM.

Numerical Results

The purpose of this section is to illustrate numerically theeffectiveness of the model and the algorithm developed above.

Problem Data

Consider a family of desktop computers that consists of six differentend products, denoted PC 1-PC 6, which are configured from a set of 18different components, or building blocks. The components are obtainedfrom external suppliers with different supply leadtimes. Table 1summarizes the data used in the numerical study, including the unit costof each component and the supply leadtime (including time for shipment).

Each end product is configured from a set of building blocks as definedby its bill-of-material (BOM). The BOM structure is displayed in Table2. The final assembly process, for each end product, takes no more than1 to 2 hours, which is order-of-magnitude shorter than the componentleadtime. So this fits well with the scenario discussed above.

We remark that the data provided in Tables 1 and 2 are based, on realdata from the PC assembly system of a major computer manufacturer. Toprotect company confidentiality, we have altered the values of the data.The modified values, however, are still relatively close to a realisticproduct representation.

We examine the performance of our model under several parametersettings. The parameters varied include the budget limit on the expectedinventory cost, demand variability (in terms of the coefficient ofvariation), and the BOM structure. We also investigate the performanceof the model when applied in a non-stationary demand environment. Wecheck the results obtained from the optimization against Monte-Carlosimulation. Simulation point estimates and confidence intervals wereconstructed from twenty independent replications with 1,000 time periodsin each replication.

TABLE 1 Unit Costs and Supply Leadtimes of the Components Cost CostLeadtime Product (in $) Component (in $) (in days) PC 1 1099 Memory 64MB 290 15 PC 2 1331 Processor 450 MHZ 307 12 PC 3 1308 Processor 500 MHZ538 12 PC 4 1243 Processor 550 MHZ 391 12 PC 5 1243 Processor 600 MHZ799 12 PC 6 1098 Shell 42 5 Shell (Common Parts 1) 114 8 Shell (CommonParts 2) 114 8 Hard Drive 6.8 GB 155 18 Hard Drive 13.5 GB 198 18 HardDrive (Common Parts) 114 8 CD ROM 43 10 CD ROM (Common Parts) 114 10Video Graphics Card 114 6 Ethernet Card 114 10 Software Pre-Load 1 114 4Software Pre-Load 2 114 4

TABLE 2 BOM Structure Component Usage PC 1 PC 2 PC 3 PC 4 PC 5 PC 6Memory 64 MB 1 1 1 1 1 1 Processor 450 MHZ 1 Processor 500 MHZ 1Processor 550 MHZ 1 1 1 Processor 600 MHZ 1 Shell 1 1 1 1 1 1 Shell(Common Parts 1) 1 1 1 1 1 1 Shell (Common Parts 2) 1 1 1 1 1 1 HardDrive 6.8 GB 1 1 1 Hard Drive 13.5 GB 1 1 1 Hard Drive (Common Parts) 11 1 1 1 1 CD ROM 1 CD ROM (Common Parts) 1 Video Graphics Card 1 1 1 1 1Ethernet Card 1 Software Pre-Load 1 1 1 1 1 Software Pre-Load 2 1

Demand Variability

We first study the effect of demand variability on the service level,inventory budget, and optimal base-stock levels. Assume that demand forthe six end products is independently identically distributed among theproducts and over the time, with a mean of E(D_(m))=100 per period; thecoefficient of variation is 0.2, 0.4, and 1.0. The budget limits arevaried so as to obtain service levels (no-stockout probabilities) atabout 90%, 95%, and 98%. The basic time period in all cases is one day.

Tables 3 to 5 summarize the numerical results for these cases. Thecolumn labeled “opt.” shows the optimal no-stockout probabilities of theend products for t e given inventory budget. The column labeled “sim.”shows the corresponding 95% confidence interval obtained fromsimulation. Input to the simulation are the base-stock levels for thebuilding blocks generated by the optimization model. The base-stocklevel of each end product is zero, since each end product follows aftconfigure-to-order operation.

TABLE 3 Comparison for End-Product Service Levels; E(D_(m)) 100;cv(D_(m)) = 0.2 B = 800,000 B = 900,000 B = 1,000,000 sim. opt. sim.opt. sim. opt. PC 1 0.949 ± 0.923 0.975 ± 0.006 0.963 0.989 ± 0.0040.984 0.010 PC 2 0.949 ± 0.923 0.975 ± 0.005 0.963 0.989 ± 0.004 0.9840.007 PC 3 0.980 ± 0.923 0.990 ± 0.003 0.963 0.995 ± 0.002 0.984 0.004PC 4 0.966 ± 0.923 0.982 ± 0.004 0.963 0.991 ± 0.003 0.984 0.005 PC 50.991 ± 0.945 0.995 ± 0.003 0.974 0.997 ± 0.002 0.988 0.003 PC 6 0.945 ±0.923 0.973 ± 0.005 0.963 0.988 ± 0.004 0.983 0.007

TABLE 4 Comparison for End-Product Service Levels; E(D_(m)) 100;cv(D_(m)) = 0.4 B = 1,500,000 B = 1,750,000 B = 2,000,000 sim. opt. sim.opt. sim. opt. PC 1 0.927 ± 0.013 0.892 0.969 ± 0.007 0.956 0.989 ±0.984 0.004 PC 2 0.928 ± 0.008 0.892 0.970 ± 0.006 0.956 0.989 ± 0.9840.004 PC 3 0.969 ± 0.006 0.892 0.987 ± 0.003 0.956 0.995 ± 0.984 0.003PC 4 0.949 ± 0.007 0.892 0.978 ± 0.004 0.956 0.990 ± 0.984 0.003 PC 50.983 ± 0.004 0.923 0.993 ± 0.003 0.969 0.997 ± 0.988 0.002 PC 6 0.919 ±0.009 0.892 0.967 ± 0.005 0.955 0.988 ± 0.983 0.004

TABLE 5 Comparison for End-Product Service Levels; E(D_(m)) 100;cv(D_(m)) = 1.0 B = 800,000 B = 900,000 B = 1,000,000 sim. opt. sim.opt. sim. opt. PC 1 0.926 ± 0.013 0.923 0.951 ± 0.011 0.957 0.967 ±0.977 0.009 PC 2 0.926 ± 0.013 0.923 0.949 ± 0.008 0.957 0.967 ± 0.9770.007 PC 3 0.954 ± 0.007 0.923 0.970 ± 0.005 0.957 0.981 ± 0.977 0.004PC 4 0.933 ± 0.008 0.923 0.953 ± 0.007 0.957 0.967 ± 0.977 0.006 PC 50.971 ± 0.006 0.945 0.981 ± 0.005 0.970 0.988 ± 0.984 0.004 PC 6 0.928 ±0.011 0.923 0.953 ± 0.009 0.957 0.969 ± 0.977 0.008

Observe that the no-stockout probabilities returned from theoptimization model is generally conservative; i.e., lower than thesimulated values. This is expected as the off-shelf availability of eachend product used in the optimization model is a lower bound of the truevalue, as explained above. Also observe that the bound becomes tighteras the service level increases, along with the increased budget.Furthermore, the bound appears to be closer to the simulation results asthe coefficient of variation (of demand) increases.

Among the six end-products, PC 5 is the only one that does not have aunique component. Observe that it alone achieves a higher service levelthan the other five end-products, which all have the same service level.In other words, all end-products with unique components have bindingconstraints in inequality (24), whereas PC 5 exceeds this service level.

For the same cases, Table 6 summarizes the comparison for the expectedoverall inventory costs. It is interesting to note that while thesimulation runs result in higher service levels, the associatedinventory costs are also slightly higher. (The relative error, however,is still well below 5%.) This suggests that in applications, when theinventory budget is a “hard” constraint, we need to input into theoptimization model an inventory budget limit that is about 5% lower thanits real value.

TABLE 6 Comparison for Expected Inventory Costs; E(D_(m)) = 100cv(D_(m)) = 0.2 cv(D_(m)) = 0.4 cv(D_(m)) = 1.0 opt. sim. rel. err. opt.sim. rel. err. opt. sim. rel. err. 800,000 841,819 4.9% 1,500,0001,554,728 2.5% 4,000,000 4,056,800 1.4% 900,000 923,893 3.5% 1,750,0001,774,716 1.4% 4,400,000 4,419,355 0.5% 1,000,000 1,014,657 1.4%2,000,000 2,010,165 0.4% 4,800,000 4,792,957 0.1%

Table 7 displays the solution found by the optimization model for thecase of cv(D_(m))=1.0. For every component, the optimal solution isshown in three forms: base-stock level R_(i)*, safety factor k_(i)*, anddays-of-supply DOS_(i). Clearly, these (optimal) values all increase as,the overall budget increases. The results also illustrate the effect ofrisk pooling: the higher the degree of commonality of a component, thelower the amount of safety stock required to maintain the service level.For instance, the safety stock for the 64 MB memory module, which isused in all six products, varies between 3.86 and 4.48 days-of-supply,whereas the safety stock for the ethernet card, which is unique to PC 3,is roughly twice that amount.

TABLE 7 Optimal Solution in Terms of Base-stock Levels, Safety Factors,and Days-of-Supply; E(D_(m)) = 100; cv(D_(m)) = 1.0 B = 4,000,000 B =4,400,000 B = 4,800,000 R_(i)* k_(i)* DOS_(i) R_(i)* k_(i)* DOS_(i)R_(i)* k_(i)* DOS_(i) Memory 64 MB 11318 2.44 3.86 11509 2.64 4.18 116892.83 4.48 Processor 450 MHz 1760 1.62 5.60 1856 1.89 6.55 1950 2.16 7.49Processor 500 MHz 1760 1.61 5.59 1856 1.89 6.55 1950 2.16 7.49 Processor550 MHz 4793 1.99 3.98 4940 2.23 4.46 5088 2.48 4.96 Processor 600 MHz1745 1.57 5.45 1842 1.85 6.42 1936 2.12 7.35 Shell 4803 3.29 3.00 48803.43 3.13 4940 3.54 3.23 Shell (Common Parts 1) 6818 2.91 3.36 6922 3.063.54 7045 3.24 3.74 Shell (Common Parts 2) 6818 2.91 3.36 6922 3.06 3.547045 3.24 3.74 Hard Drive 6.8 GB 7251 2.52 6.17 7390 2.71 6.63 7540 2.917.13 Hard Drive 13.5 GB 7028 2.21 5.42 7192 2.44 5.97 7356 2.66 6.52Hard Drive (Common Parts) 6818 2.91 3.36 6942 3.09 3.57 7045 3.24 3.74CD ROM 1863 2.73 8.62 1921 2.91 9.21 1978 3.09 9.77 CD ROM (CommonParts) 1742 2.35 7.42 1809 2.56 8.08 1877 2.77 8.76 Video Graphics Card4538 2.81 3.08 4638 2.99 3.27 4729 3.16 3.46 Ethernet Card 1742 2.357.42 1809 2.56 8.0 1877 2.77 8.76 Software Pre-Load 1 2740 2.85 2.852805 3.01 3.01 2878 3.19 3.19 Software Pre-Load 2 795 1.97 3.94 842 2.214.41 889 2.44 4.88

Unique Components

Next, we illustrate the special case that each end-product involves atleast one unique component, in particular, the verification of theoptimality equations (26) to (29), as discussed at the end of the lastsection. Recall, in the above example, PC 5 is the only end-product thatdoes not have a unique component. To obtain a scenario where each endproduct has at least one unique component, we modify the originalbills-of-materials structure by letting PC 3 and PC 4 both use the 6.8GB hard drive, while reserving the 13.5 GB hard drive as a uniquecomponent for PC 5. This way, PC 5, like all the other end-products,also has unique component.

We run the greedy algorithm on this modified BOM structure fo the caseof cv(D_(m))=1.0. The results are summarized in Tables 8 and 9. Noticethat the six end products now achieve the same service level becausethey all have unique components, and thus all constraints in inequality(24) become binding.

TABLE 8 Comparison for End-Product Service Levels (With Each End-ProductHaving at Least One Unique Component); E(D_(m)) = 100; cv(D_(m)) = 1.0 B= 4,000,000 B = 4,400,000 B = 4,800,000 sim. opt. sim. opt. sim. opt. PC1 0.934 ± 0.012 0.933 0.956 ± 0.010 0.963 0.971 ± 0.981 0.008 PC 2 0.932± 0.009 0.933 0.956 ± 0.007 0.963 0.971 ± 0.981 0.006 PC 3 0.961 ± 0.0060.933 0.975 ± 0.005 0.963 0.985 ± 0.981 0.003 PC 4 0.940 ± 0.007 0.9330.958 ± 0.006 0.963 0.972 ± 0.981 0.005 PC 5 0.946 ± 0.009 0.933 0.965 ±0.008 0.963 0.978 ± 0.981 0.007 PC 6 0.936 ± 0.010 0.933 0.959 ± 0.0090.963 0.973 ± 0.981 0.007

When comparing the results for the original and modified BOM structuresas shown in Tables 7 and 9, we find that the optimization producessimilar days-of-supply targets for all components except the two harddrives. The safety stock of the 13.5 GB hard drive increases from 5.42to 8.19 days-of-supply, whereas that of the 6.8 GB hard drive decreasesfrom 6.17 to 5.05 days-of-supply. This again is a consequence ofrisk-pooling because modifying the BOM structure increases thecommonality of the high-capacity hard drive, and at the same timedecreases the commonality of the low-capacity hard drive.

To verify the optimality equations, recall from the discussion abovethat we first determine the Lagrangian multipliers, λ_(m) and η, basedon the solutions returned by the algorithm, and then check the equationsin (26) for all the non-unique components. Table 10 lists the gap,labeled “abs.err.”, between the left hand side and the right hand sideof the equations in (26) for all the non-unique components. The gap isindeed very small, on the order of 10⁻⁸ or below. This clearly indicatesthat in this case the greedy algorithm has returned an optimal solution.(That there is a gap at all is mainly due to discretization.) The othertwo cases, with the coefficients of variation being 0.2 and 0.4, yieldsimilar results.

TABLE 9 Optimal Solution in Terms of Base-Stock Levels, Safety Factors,and Days-of-Supply (With Each End-Product Having at Least One UniqueComponent); E(D_(m)) = 100; cv(D_(m)) = 1.0 B = 4,000,000 B = 4,400,000B = 4,800,000 R_(i)* k_(i)* DOS R_(i)* k_(i)* DOS R_(i)* k_(i)* DOSMemory 64 MB 11357 2.48 3.93 11542 2.68 4.21 11731 2.88 4.55 Processor450 MHz 1781 1.68 5.81 1876 1.95 6.75 1970 2.22 7.69 Processor 500 MHz1781 1.68 5.81 1876 1.95 6.75 1970 2.22 7.69 Processor 550 MHz 4788 1.983.96 4936 2.23 4.45 5088 2.48 4.96 Processor 600 MHz 1767 1.63 5.66 18631.91 6.62 1956 2.18 7.56 Shell 4837 3.35 3.06 4940 3.54 3.23 5038 3.723.40 Shell (Common Parts 1) 6843 2.95 3.40 6963 3.12 3.60 7080 3.29 3.80Shell (Common Parts 2) 6843 2.95 3.40 6963 3.12 3.60 7080 3.29 3.80 HardDrive 6.8 GB 11525 2.66 5.05 11703 2.85 5.40 11881 3.04 5.76 Hard Drive13.5 GB 2619 1.93 8.19 2724 2.18 9.23 2827 2.42 10.26 Hard Drive (CommonParts) 6843 2.95 3.40 6963 3.12 3.60 7080 3.29 3.80 CD ROM 1860 2.728.59 1921 2.91 9.21 1978 3.09 9.77 CD ROM (Common Parts) 1739 2.33 7.381807 2.55 8.06 1877 2.77 8.76 Video Graphics Card 4561 2.85 3.12 46633.04 3.33 4750 3.19 3.50 Ethernet Card 1739 2.33 7.38 1807 2.55 8.061877 2.77 8.76 Software Pre-Load 1 2752 2.88 2.88 2825 3.06 3.06 28963.24 3.24 Software Pre-Load 2 793 1.96 3.92 842 2.21 4.41 890 2.45 4.89

TABLE 10 Optimization Results for Non-Unique Components (Scenario WhereEach End Product Has at Least One Unique Component); E(D_(m)) = 100;cv(D_(m)) = 1.0 B = 4,000,000 B = 4,400,000 B = 4,800,000 x_(i)* abs.err. x_(i)* abs. err. x_(i)* abs. err. Memory 64 MB 0.0073 5.20⁻⁸ 0.00413.04⁻⁸ 0.4983 1.68⁻⁸ Processor 550 MHZ 0.0233 3.02⁻⁸ 0.0129 1.84⁻⁸0.4949 1.10⁻⁸ Shell 0.0005 5.59⁻⁸ 0.0003 3.78⁻⁸ 0.4999 2.26⁻⁸ Shell(Common Parts 1) 0.0018 5.31⁻⁸ 0.0011 3.20⁻⁸ 0.4996 1.73⁻⁸ Shell (CommonParts 2) 0.0018 5.31⁻⁸ 0.0010 3.20⁻⁸ 0.4996 1.73⁻⁸ Hard Drive 6.8 GB0.0059 5.21⁻⁸ 0.0034 3.10⁻⁸ 0.4987 1.70⁻⁸ Hard Drive (Common Parts)0.0018 5.31⁻⁸ 0.0011 3.20⁻⁸ 0.4996 1.73⁻⁸ Video Graphics Card 0.00254.08⁻⁸ 0.0014 2.58⁻⁸ 0.4994 1.24⁻⁸ Software Pre-Load 1 0.0022 2.72⁻⁸0.0013 1.76⁻⁸ 0.4995 0.93⁻⁸

Non-Stationary Demand

We next examine the effectiveness of the algorithm in handlingnon-stationary demand. For instance, when the demand forecast changesweekly, we can run the optimization model at the beginning of each weekusing the demand offset scheme described above. The base-stock levelsare then updated weekly, based on the outcome of the optimization.

To illustrate this approach, consider the product structure described inTable 1. Consider a planning horizon of 100 weeks, over which the meandemand for each end-product changes weekly, while the coefficient ofvariation (which measures the forecast error) remains constant.Specifically, we randomly generate the weekly demand from a uniformsample over the interval [525,875], while maintaining the coefficient ofvariation at 2.646. Using the algorithm that solves the “dual” problemdescribed in (31) and (32), we minimize the total expected inventorycost subject to a set of target no-stockout probabilities, 90%, 95%, and98% (corresponding to β=0.10, 0.05, and 0.02). Table 11 compares theachieved service levels and the total expected inventory cost betweensimulation and the optimization model. Input to the simulation are thecomponent base-stock levels, by week, generated by the optimizationalgorithm.

TABLE 11 Comparisons for End-product Service Levels and Total InventoryCost in Non-Stationary Demand Environment β = 0.10 β = 0.05 β = 0.02sim. opt. sim. opt. sim. opt. PC 1 0.928 ± 0.009 0.900 0.952 ± 0.0070.950 0.971 ± 0.004 0.980 PC 2 0.926 ± 0.007 0.900 0.949 ± 0.005 0.9500.969 ± 0.003 0.980 PC 3 0.944 ± 0.006 0.900 0.962 ± 0.004 0.950 0.975 ±0.003 0.980 PC 4 0.929 ± 0.007 0.900 0.951 ± 0.006 0.950 0.968 ± 0.0040.980 PC 5 0.950 ± 0.006 0.900 0.965 ± 0.004 0.950 0.978 ± 0.003 0.980PC 6 0.922 ± 0.009 0.900 0.950 ± 0.008 0.950 0.970 ± 0.005 0.980 Totalcost $4,039,913 $3,830,505 $4,505,698 $4,329,152 $5,077,240 $4,924,748

For 90% and 95% service level targets, the simulated no-stockoutprobabilities do exceed the values returned by the optimization. At 98%service level, the simulated values are slightly below their analyticalcounterparts. This is largely due to the weekly update of the base-stocklevels: whenever there is an increase in demand, and hence an increasein base-stock levels, from one week to the next, there is a time lag inbuilding up the inventory, due to the supply leadtime, and the availablestock may be insufficient to accommodate the increase in demand. Thisshortfall can be eliminated if the base-stock levels are updated morefrequently, say, daily. We further observe that the analytical estimatesof the expected total inventory cost are within 5.5% of the simulatedvalues.

FIG. 4 shows the optimal safety-stock levels (i.e., base-stock minuswork-in-progress (WIP)) converted to days-of-supply (DOS), for a subsetof components in the example. Notice that the DOS values fluctuate verylittle over time. This suggests, in situations where the forecast error(in terms of its coefficient of variation) remains relatively constantover time, it suffices to follow a simple policy that tracks, for eachcomponent inventory, a constant DOS target (instead of updating thebase-stock levels, which keep changing from period to period). Further,the results clearly demonstrate the benefit of risk-pooling: buildingblocks that go into a larger number of end products (e.g., memorymodules) require much less safety stock than building blocks that areonly used in a small number of end products (e.g., CD ROMs).

Process Re-Engineering Application

Here we describe the study mentioned earlier, which was part of a largerproject aimed at the re-engineering of an existing business process froma build-to-stock operation to an assembly-to-order operation centeredaround “building blocks” (i.e., keeping inventory only at the componentlevel). To carry out the study, we have developed two basic models: the“as-is” model that is a reflection of the present operation, and the“to-be” model that is based on the optimization model described in theprevious sections—in particular, with the component inventory levelsgenerated by the algorithm. For both models, we aggregate the business'production-inventory system into two stages, the first stage consists ofthe components, or building blocks, and the second stage includes theassembly and the order fulfillment.

Three factors have been identified as focal points of our study:

-   -   (i) manufacturing strategy—the “as-is” operation versus the        “to-be” model;    -   (ii) the accuracy of demand forecast at the end-product level        versus at the component level; and    -   (iii) the effect of mass customization as a result of, for        instance, direct sales over the internet.

To study the first factor, we select a major product family at thebusiness, which consists of 18 end-products configured from a total of17 components. We use the business' existing data—including BOM, unitcosts, assembly and procurement leadtimes—to run a detailed simulationmodel. The demand for each end-product is statistically generated, basedon historical data. The days-of-supply targets are set to meet arequired service level of 95% (for all end-products). Following thebusiness' current practice, these targets are determined using acombination of simple heuristic rules and judgement calls from productmanagers, and verified by simulation (via trial and error).

We then feed the same data, including the same statistically generateddemand streams, into the optimization model, which eliminates thefinished-goods inventory at the end-product level and optimally sets thebase-stock level for each component inventory. The optimization modelminimizes the overall inventory cost while meeting the same servicelevel of 95% for all end-products. We take the optimal base-stocklevels, and rerun the simulation to verify the analytical results.

FIG. 5 shows the comparison between the “as-is” and the “to-be” models,in terms of the overall inventory cost. (To protect proprietaryinformation, the vertical axis in all figures is normalized with respectto the inventory cost of the “as-is” model, which is 100.) As expected,the inventory cost at the end-product level is virtually eliminated inthe “to-be” model. (The cost shown is due to WIP; the cost due tofinished goods is nil.) In contrast, the “as-is” model keeps asignificant amount of end-product inventory. On the other hand, theamount of component inventory is higher in the “to-be” model, which isagain expected, since the required service level of 95% is common toboth models. Overall, the “to-be” model reduces the overall inventorycost by about 30%.

Note in the above study, both models use the same demand forecast, atthe end-product level. The “to-be” model, however, can easily switch toforecasting demand directly at the component level. This will result inimproved forecast accuracy, as we can take advantage of partscommonality, as each component is generally used in several endproducts. Hence, in our study of the second factor, we evaluate theeffect of forecast accuracy through a sensitivity analysis. FIG. 6 showsthe overall inventory cost associated with three different levels offorecast accuracy. The first two columns, repeat the comparison in thelast figure; i.e., both (“as-is” and “to-be” models assume 30% forecasterror (i.e., the coefficient of variation equals 0.3) at the end-productlevel; the next two columns represent improved forecast errors, at 20%and 30%, achieved by the “to-be” model through forecasting at thecomponent level.

Our study of the third factor aims at analyzing the impact on inventorywhen the system supports a richer product set, in terms of productvariety. The motivation is to support mass customization. In theInternet-based, direct-sales environment, for instance, the number ofdifferent product configurations that customers want to order can besignificantly larger than what is currently supported in thebuild-to-stock environment. FIG. 7 shows the inventory costs: the fourcolumns on the left correspond to the current product set (1×), with thefirst scenario (S1) being the “as-is” model, and the other three beingthe “to-be” model at the current (S2) and improved (S3, S4) forecastaccuracy levels, respectively; the four columns on the right repeatthese scenarios with a product set that is ten times as large in variety(10×), while maintaining the overall volume. (Also refer to Table 12 fora summary of all the different scenarios.)

Observe that as the product variety increases, a significantly higherlevel of inventory is required in the “as-is” model. This is becauseforecast accuracy will deteriorate when the end products proliferate(i.e., larger varieties at smaller volumes). On the other hand, in the“to-be” environment, the increase in inventory cost is very modest. Thisis because the proliferation of end-products will have minimal effect onthe forecast accuracy at the building-block level, due to partscommonality. This strongly supports the fact that the building-blockmodel is the right process to support an internet-based, direct-salesoperation.

TABLE 12 Summary of the Scenarios Used to Study the Effect of ProductVariety Scenario Description 1x Cases 10x Cases S1 “as-is” originalproduct set, ten times larger product 30% forecast error, set, 30% ×{square root over (10)} forecast 90% service error at MTM level S2“to-be” forecast at MTM ten times larger product level, 30% forecastset, forecast error as error, 90% service in S2(1x) S3 “to-be” forecastat BB level, ten times larger product 20% forecast error, set, forecasterror as in 90% service S3(1x) S4 “to-be” forecast at BB level, tentimes larger product 10% forecast error, set, forecast error as in 90%service S4(1x)

The examples given demonstrate the advantages of the invention appliedto the business of manufacturing personal computers (PCs). However, theinvention has applications to other configure-to-order (CTO)manufacturing systems and is not limited to manufacturing PCs. Thus,while the invention has been described in terms of a single preferredembodiment, those skilled in the art will recognize that the inventioncan be practiced with modification within the spirit and scope of theappended claims.

1. A method of managing manufacturing logistics of multiple end productsfor which no finished goods inventory is kept, and while a manufacturingprocess migrates from an existing operation to a Web-basedconfigure-to-order (CTO) operation, wherein a CTO operation is a hybridof make-to-stock and make-to-order operations; comprising the followingsteps which are performed without keeping finished goods inventory forany end product; and each of which method step is performed while themanufacturing process migrates from the existing operation to theWeb-based CTO operation: maintaining an inventory of components, whichcomponents, termed “building blocks”, are built to stock, each saidcomponent having a cost wherein the cost is stored in a database;according to the Web-based CTO operation which is the hybrid ofmake-to-stock and make-to-order operations, configuring-to-ordermultiple different end products using said components as defined by abill of materials (BOM) structure wherein the BOM structure is stored ina database, wherein each end product involves at least one uniquecomponent; wherein the multiple different end products comprise sixdifferent end products; and wherein the end products have a demandforecast that changes weekly; meanwhile taking customer orders from theInternet as the manufacturing process migrates from the existingoperation to the Web-based CTO operation.
 2. The method of managinglogistics of end products recited in claim 1, where the end products arepersonal computers (PCs) and the components are stock computercomponents.
 3. The method of managing manufacturing logistics of endproducts recited in claim 1, including deriving the base-stock levelsfrom a greedy algorithm which iteratively reduces inventory budget untila budget constraint is satisfied. 4-15. (canceled)
 16. The method ofclaim 1, including the processor receiving input from a database thatcontains optimization control parameters comprising budget limit onexpected overall inventory cost and step size for a greedy algorithm,and also from a database that contains manufacturing system parameters.17. The method of claim 16, in which the processor accesses thedatabases and first performs preprocessing steps, after which theprocessor performs optimization processing, after which the processorenters a postprocessing phase and performs a step of computing reorderpoints.
 18. The method of claim 17, including after the computing ofreorder points, translating the reorder points into days-of-supply andoutputting to an output device or database days-of-supply for eachcomponent.
 19. The method of claim 1, in which the steps are performedwhere the end products are a family comprising six different endproducts configured from a set comprising 17 different components whichare obtained from external suppliers with different supply leadtimes.20. The method of claim 1, comprising performing an optimization run ata week's beginning and then updating base-stock levels weekly based onoutcome of the optimization.
 21. The method of claim 1, wherein themanufacturing system parameters, in the database that contains themanufacturing system parameters, comprise: (i) demand for end productmεM in period t=1, 2, . . . T; (ii) inbound leadtime distribution forcomponent iεS; (iii) outbound leadtime distribution for end product mεM;(iv) distribution of number of units number of units of component i usedin assembly of end product mεM; (v) unit cost of component iεS; (vi)bill of materials for end product mεM.
 22. The method of claim 1,comprising steps, performed by the processor, of propagating a demandand computing a mean and a variance of the demand over a leadtime. 23.The method of claim 1, comprising a step, performed by the processor, ofcomputing reorder points.
 24. The method of claim 23, comprisingtranslating the reorder points into days-of-supply.
 25. The method ofclaim 21, comprising outputting, to an output device or a database, aset of computed information comprising (a) days-of-supply for eachcomponent iεS and (b) achieved service level for each end product mεM.26. The method of claim 1, wherein an end product is characterized by afinal assembly process of that takes no more than 2 hours, and componentleadtime is days-long.
 27. The method of claim 1, wherein componentscomprise a memory component; a processor component; a shell component; ahard drive component; a CD ram component; a video graphics cardcomponent; an ethernet card component; and a software pre-loadcomponent.
 28. The method of claim 1, wherein components comprise: amemory component; a processor component; a shell component; a hard drivecomponent; a CD rom component; a video graphics card component; anethernet card component; and a software pre-load component.